Don't let it get away!

Debt is a dangerous tool. Used wisely, it can help you make investments that can propel you to heights you couldn't have achieved without it. But as millions of former students are finding out, used poorly -- or if you just run into some bad luck -- debt can put you into a deep hole financially, and it's harder than ever to get yourself out of that hole.

The state of the student loan industryYesterday, credit bureau TransUnion released a study that looked at the student loan industry over a five-year period from March 2007 to March 2012. The findings confirmed what many people already realized: Student loan debt has become a much more serious problem, as the impact of the recession and sluggish recovery from the financial crisis has hit job-seekers extremely hard and forced many graduates already saddled with debt to take measures to get relief.

In particular, some of the more troubling stats as of the end date of the study include the following:

More than half of all student loan accounts -- 65 million in all -- were in deferred status, with deferred loans making up well over 40% of the total outstanding balances on student loans.

Student loan balances in deferment soared by 75% over the five-year period to hit $388 billion, and average debt rose 30% to nearly $24,000 per borrower.

More than half of college graduates under age 25 are unemployed or underemployed.

Delinquency rates rose dramatically over the time period.

All of these data points show the unfortunate combination of (1) students believing that they need to go or return to school in order to boost their career prospects and (2) then finding that their college or graduate degrees don't come close to guaranteeing them any job at all, let alone one that justifies the substantial investment they've made in their education.

Why banks have opted outOne interesting piece of information revealed in the report points to differences between student loans that are backed by the federal government versus private student loans. Borrowers tend to prefer subsidized federal loans the best, because their terms are usually more attractive and provide for interest-free deferments. But when financial aid awards are insufficient to meet tuition, private lenders traditionally stepped in to bridge the gap -- often at high interest rates with less generous provisions for deferment or forbearance.

You might think that private loans would be more likely to be in default due to their more onerous terms. But surprisingly, private loan activity has become relatively unimportant in the industry. Federal loan balances nearly doubled from 2007 to 2012, but private loan balances barely budged. Moreover, delinquency rates for private loans were less than half the rates for federal loans, with private-loan delinquencies actually dropping over the time frame.

The trend away from private loans likely comes from bank decisions not to offer them. Bank of America (NYSE: BAC) stopped originating student loans more than three years ago, and as Fool contributor Amanda Alix wrote in mid-2012, other banks followed suit, with US Bancorp (NYSE: USB) no longer taking applications for student loans as of last March and JPMorgan Chase (NYSE: JPM) planning to limit student loans to existing customers.

That doesn't mean you can't get private loans. Wells Fargo (NYSE: WFC) , Sallie Mae (NASDAQ: SLM) , and many other banks still offer them, and with Sallie Mae offering fixed rates as high as 11.85% and at least one Wells Fargo loan quoted at rates of more than 14%, these loans can be extremely lucrative for banks -- albeit while carrying substantial risk.

Be careful out thereIf you're already in debt, the key takeaway here is to understand that getting into more debt isn't a good solution to your problem. Education is no guarantee of a well-paying job, so get a sense now of whether your chosen career path is likely to pan out. If prospects are dim, cutting your losses may help avoid bigger problems down the road.

Meanwhile, the easier lesson is for those in high school who haven't yet incurred college debt. Realize that college education is an investment, and you need to weigh the potential return on that investment before going into debt. If you're uncertain that a given school will give you the payoff you want, look for alternatives that will. Only once students and prospective students start thinking financially will the student-loan debt crisis come to an end.

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Comments from our Foolish Readers

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"Only once students and prospective students start thinking financially will the student-loan debt crisis come to an end."

This is yet another article that blames the student loan debt crisis on young students, and gives a free pass to the lenders and educational institutions that are the ultimate source of the problem.

Behind every foolish borrower is an equally foolish lender. But the current system -- and those who support the current system, like the author of this article -- is designed only to punish borrowers.

If Congress once again allows people to discharge their student loan debt through bankruptcy -- just as people can declare bankruptcy for credit card debt, bad mortgages and even gambling debt -- the problem will be solved.

jdmeck -- I see your logic has been so perverted by the lending industry that you lost the capacity to think for yourself.

You are obviously ill-informed and lack empircal evidence for your claims. But if you want to continue through life viewing the world through a prism of basless assumptions and sweeping generalizations, nobody can stop you.

Even Salie Mae -- a large private lender -- approves of restoring bankruptcy protection for students who have made a good-faith effort to repay their loans for 5 to 7 years.

The bottom line is you cannot provide any valid justification for why some people can discharge bad credit card, mortgage or gambling debts, whereas hard-working graduates who fell on tough times are prohibited from discharging private student loan debt.

Federal student loan debt is another issue. There, you have a stronger argument for prohibiting bankruptcy, but that's only because federal student loans come with many protections that their private counterparts do not afford.

Anyhow, you're a good little servant of the lending industry. I'm sure your parents are proud.

I think I am just going to start every comment on this site, at least every policy-oriented comment, by quoting Charlie Munger: "Never, ever, think about something else when you should be thinking about the power of incentives."

Regarding blaketpa's 1st comment: You are right in that for every bad loan taken out, there is a bad loan issued by the lender, as well, by definition. But who has more at stake? For you, individually, as a borrower, taking a potentially bad loan can permanently ruin your finances. For the bank? Some lost revenue to be sure, but they'll be fine. I promise. In fact it's government policy now that banks can't go out of business.

Both sides of the equation are taking on risks and therefore deserve part of the blame. It's just that banks are monumentally better able to bear that risk than individuals and therefore, it makes sense for individuals to approach the situation more cautiously.

The reality is that colleges and grad schools have largely arbitraged away the life-time earnings benefit of going to college or grad school -- by increasing their tuitions so much.

This is yet another wealth transfer from the young to the old. In this case from the young to baby-boomer professors and administrators at universities, and to the elderly, too, at public instititutions, because state legislatures have routinely funnelled money to medicare and pensions and away from state university budgets, who have made up the difference with...tuition increases.

The reality is, if you can't go to a top 75 college (and can't or won't get a useful science/math/econ degree if you are it the bottom 50 of those, or go to grad school), or a top-30 law school, or a top-15 business-school, etc., it may not be worth the time/money to go at all, unless you either qualify for serious scolarships at said school, or you are pretty certain you can graduate at or near the top of your class.

In the lawschool context, people have realized this a bit, which is why applications are at a 30-year low. There is just no point in graduating middle of the class at the 150th ranked law school unless you want to immediately hang out your shingle afterwards and chase ambulances.

Until congress restores standard consumer protections on student loans, the same protections that existed in 1990 when they started stripping those protections away from consumers, the student loans will continue to be a life threatening burden that students will carry for the rest of their lives unless they are lucky enough to be part of the group that was able to pay back their loans.

The entire system is the biggest predatory lending scam in the history of the USA.

You need to treat your personal finances like a big bank or multinational corporation; take out the loan, live high on the hog (or better yet, buy some real estate or gold with it, just make sure your assests are held by a shell corp you own), then use every loophole available to escape it. Use the loan money to build a cash-only business (like rental units on the land you bought with the loan). Move somewhere tropical and disconnected (Belize? Panama?) and don't come back to the US except to vacation. Better yet, use your loan money to buy foreign real estate and build a cash only business there. Thats how the fat cats do it, anyways.

To restore sanity you have to restore the bankruptcy option. It's the only way to motivate the lenders to be more frugal with lending. True there would be less loans and it would put pressure on schools to lower tuition or close shop due to empty seats. Right now the solution is just borrow more and they are. These statistics don't paint the true picture since they're only tracking 3 years post grad. Most people will exhaust all assets to keep on top of the loans but this can only get them so far. Just think what would happen if we had no bankrutpcy option under any circumstances. You borrowed to buy a home and can't pay back, too bad you have to keep paying. You took out business loans and your business isn't making ends meet? too bad you have to keep paying even if it means you don't get to buy healthcare insurance and die early. Oh well, you borrowed, you pay. What would our society look like if this is how things operated? We'd be surrounded by poverty.

Sending report...

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.
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